By Ram Charan

CRISES can strike any corporation without notice, potentially destroying huge amounts of shareholder value.

When crises occur, they divert the attention of both management and the board of directors, sapping precious human energy. Many companies are in the midst of a crisis caused by the meltdown of the global financial system.

Their leaders can hardly focus on anything other than trying to anticipate how to deal with the fallout.

The lesson is that top management must do their best to prevent crises, but they can't prevent them all. So they must also be prepared to take charge and perform damage control when a crisis erupts, even if it is something they have never experienced before.

There are basically two types of crises: those that are knowable, meaning they happen from time to time but at unpredictable intervals and with varying ferocity; and those that are unknowable, meaning no one has imagined such an event. Top management has to prepare for both the knowable unknowns and the unknowable ones to minimise disruption to the business, damage to the brand and company reputation, and loss of income.

Knowable Unknowns

Any kind of crisis that has previously taken place anywhere belongs in the category of knowable unknowns. They should not be a complete surprise, and some expertise will exist somewhere to deal with them. Leaders need to benchmark these practices as a preparedness measure.

Some crises are internally inflicted. They include situations created by management: loading the balance sheet with high debt that may cripple the company if external conditions deteriorate, relying heavily on a few customers; failing to enforce compliance on safety, health, and environmental regulations; engaging in unethical practices such as price fixing; and providing lax oversight of operations which delays a major launch. Examples of these include the Airbus 380 and Boeing 787 which faced several consecutive long delays.

Top management or their boards can cause a crisis, too. For instance, by leaking information to the press or making board business public. In 2002, a frustrated member of the Hewlett Packard board led a proxy battle to block the company's planned merger with Compaq. The distrust lingered long after the event, and the board subsequently decided not to renominate the frustrated member. Management couldn't help but be distracted by the daily media scrutiny.

Boards also can create a crisis when they have a tin ear to shareholder complaints for too long. You cannot be an ostrich when dealing with investors.

Ignoring mounting criticism doesn't make it go away. Expressing confidence in a CEO publicly and then letting him or her go days later seriously damages the company's credibility.

Crises from outside the company are increasingly common. Wal-Mart was caught by surprise by public coalitions who protested employee wages and benefits and got the attention of the media.

The issue picked up ferocious speed and momentum and terrified management (not to mention stockholders) as it began to damage the company's brand and reputation. Wal-Mart's directors were shocked and failed to deal with it for a long time.

Product recalls can be triggered by external sources. The case in which Tylenol was contaminated produced a lot of lessons for anyone who has to deal with such a crisis. Coca Cola experienced similar crises in Belgium and India, where Pepsi also had the safety of its product called into question.

Top management should first watch for these crises while they are in the making. The problem might lie in shareholder communications that are vague about the company's strategic direction or other areas that can be easily remedied. Poor relations with regulators, for example, can incite criticism and later erupt into a full blown crisis, but the problem may be fixable by coaching the CEO or encouraging him to bring in additional talent.

It makes sense for the board of directors to have a lengthy discussion about the substance of any criticism they are picking up and to explore the possibility of corrective action. Headlines are rife with stories of crises that could have been detected and dealt with.

Take, for instance, the case of a CEO who charms the board and the public but is toxic to everyone inside.

Subordinates steadily depart and 'yes men', who tolerate the abuse because they are compensated handsomely, take their place. Such a problem can erupt into a crisis if the dysfunctional behaviour crosses legal bounds, for instance, or the displaced executives begin to go public.

Every organisation needs to decide which categories are important enough to prepare for ahead of time. The role for boards is to ensure that management has considered them and has appropriate mechanisms and processes in place to deal with a range of threats.

Some companies have a core group that forms a crisis committee comprising the CEO and top office holders and the public relations and communications director. Additional members can be called on depending on the nature of the problem. The plans should be updated as new information becomes available.

In each case, there must be a point person in charge and a game plan that can be deployed instantly. One of the key ingredients of the game plan is the ability to communicate extensively on short notice.

Coke Case

Former Coca Cola CEO Doug Ivester waited one week before making a public statement after dozens of Belgian youth fell ill drinking Coke in June 1999, despite at least one board member counselling him to speak immediately. It took months to restore Coca Cola's reputation in Europe.

The plans should be reviewed by the appropriate committee of the management team or board of directors, perhaps the risk committee. The committee should decide who the point person will be for the board and establish its own procedures for contacting all directors.

An audit committee member might be a good choice for financial crises, for example, while a director with a legal or public policy background could play the role in some other circumstances.

It should lay the ground rules for ensuring decisions are not delayed because board approval is needed.

The committee and the point director must be psychologically equipped to have a steady hand to calm the nerves of the various players, including perhaps a CEO who becomes rattled in a crisis.

Preparing a list of advisors or experts available at all hours and keeping contact information current can save valuable time in the heat of the moment.

Periodically rehearsing a crisis can test how well the mechanisms and processes are working.

Dealing with Unknowable Unknowns

The unknowable unknowns are impossible to detect before they erupt, even though they might be brewing for some time, because no one has ever seen them before. When they become apparent, the impact is hard to predict. No one knows how long or deep the problem might be.

Management must prepare for them nonetheless by using their usual crisis plan with two major differences.

First, the people and teams assigned to confront such a crisis need to have the skills to seek and sift through information from a large variety of sources and construct multiple scenarios on the fly. They must have the confidence to act decisively and construct worst case scenarios even when many factors are unknown and ambiguous.

Secondly, the board or top management must be prepared to take the lead. During the crisis, the point person from the board must stay in close touch with management as they sort out what is happening. Here the board can be an important check on management's interpretation of events, because even the best CEOs can sometimes be too optimistic or have blind spots.

Rich Noll, CEO of Hanesbrands, comments: 'The board makes sure that we're not just working on one plan, but rather on a broad range of scenarios. They help us think about the unknowable; make sure we're managing the 'black swan' type of risks, in addition to the things you can predict.'

At the same time, directors can share their own experiences from analogous situations to help fill in the CEO's blind spots.

'People tend to be too optimistic or too pessimistic,' says Noll. 'The board can help management maintain a balanced perspective.' The board should also help management imagine what the domino effect might be, projecting what other problems might arise as one thing triggers something else.

Take, for instance, a company that is facing imminent liquidity problems. If the lenders sense the company's problems, a vicious cycle can begin in which the cost of borrowing increases, credit tightens further, and terms of refinancing become onerous, all exacerbating pressure on management and finances.

At the first sign of a cash crisis, management must keep asking where cash is coming from and going as they weigh different scenarios and courses of action. This deliberation includes all sources of cash commitments, whether on or off the balance sheet.

Which partnerships are the company locked into, and which customers or suppliers are at risk? If something starts to shift in the wrong direction, what else might happen? Those considerations will help management formulate a realistic Plan B or C.

The board of directors must be prepared to take charge if management is slow to grasp the situation and take the lead. Consider the unprecedented financial meltdown in 2008, which left no one untouched worldwide and left many people without the nest egg they had spent decades building.

Why was it an unknowable unknown?

The global financial system spun out of its regular rhythm and went out of control. It never occurred to anyone that such a thing could happen.

Corporations have faced high leverage and tight credit before, but not the breakdown of the whole financial system and such an abrupt constriction of money flows.

It made some business models inoperative, and boards had to engage immediately to try to take their companies to safety. Waiting for management to make a move is a mistake. Management, after all, has never been tested under the conditions of an unknowable unknown, and the board cannot assume that they know how to respond.

Obviously, the boards of Lehman Brothers, Bear Steams, General Motors failed to realise that their management was not able to sense the magnitude and cope with the economic tsunami.

Some boards took charge of the dire situation and moved fast. In some cases they fired the CEO (as at Merrill Lynch); in other cases they reaffirmed their confidence in the CEO and the management team. Their communication became very frequent as they worked hard to stay synchronised and ahead of the changing picture.

In one company, the board met six times in two months, and all directors attended all meetings and were instantly available to make rapid decisions.

Any delay or less engagement on the part of the board could have been disastrous for the shareholders and employees of that company.

Leaders have to practise 'management intensity'. This is defined as a deep immersion in the business's operational details and the day-to-day competitive climate that the business is facing, along with hands-on involvement and follow-through.

It's crucial because of the accelerating speed at which things are changing. Surviving a volatile environment requires frequent operational adjustments.

You hear about new layoffs and downward projections. Keeping up with news like that and tracking their effects is crucial, because a cut today will initiate cuts elsewhere tomorrow.

It's not enough to sit in the office and read reports and issue directives. Top management must know what's happening daily, and adjust plans and processes accordingly.

Big-picture strategic thinking is still important, but it must take a back seat to this operational immersion - leaders need to be involved and visible, and communicating all the time.

Their guiding principle should be: Head in, hands on. Only in this way will they be able to anticipate what's coming next and respond quickly and appropriately.

Ram Charan is an acclaimed business advisor, speaker, and author. He has worked behind the scenes coaching some of the world's successful CEOs at companies like GE, DuPont, EDS, and Ford.

He will present the SIM Annual Management Lecture on 12 August 2009. Details at 62489452 and 62489448.

Dr Ram Charan will be in Singapore on 12 August in an event organised by the Singapore Institute of Management. Details as follows:

Date: 12 August 2009
Venue: Fairmont Singapore (Raffles City Convention Centre)

Senior Management Seminar
Breaking Barriers - Leaders At All Levels
8.30 am - 12.30 pm (Registration and breakfast buffet from 8 am)
Fee: S$850 / S$950 (SIM Members / Non-members)

SIM Annual Management Lecture
Leadership in the Raging Economic Cyclone - New Rules for Thriving in Difficult Times and Beyond
3 pm - 5 pm (Registration, networking and tea reception from 2 pm)
Fee: S$450 / S$550 (SIM Members / Non-members)

Enquiries: Joey Tan | joeytan@sim.edu.sg | +65 6248 9452
                Jacqueline Low | jacquelinelow@sim.edu.sg | +65 6248 9448